May14,2012 DavidA.Stawick Secretary CommodityFuturesTradingCommission ThreeLafayetteCentre 115521stStreet,NW Washington,DC20581 Re:RIN3038AD08;InConsiderationofAppropriateBlockTradingThresholdswithRegardtoSwaps ExecutionandTradeReporting DearMr.

DearMr.Stawick: The Swaps & Derivatives Market Association (SDMA) appreciates the opportunity to provide comments to the Commodity Futures Trading Commission (the CFTC) on the CFTCs Notice of Proposed Rulemaking regarding Procedures To Establish Appropriate Minimum Block Sizes for Large NotionalOffFacilitySwapsandBlockTrades(17CFRPart43). TheSDMAisanonprofitfinancialtradegroupformedin2010tosupportthegoalsoftheDoddFrank Act. It believes that systemic risk of OTC derivatives can be mitigated through their regulation, the creationofcentralclearing,andbyensuringopenandtransparentaccesstoensuregreatercompetition, lower transaction costs and greater liquidity. The SDMA is comprised of many US and internationally based brokerdealers, investment banks, futures commission merchants and asset managers participating in all segments of the exchangetraded and overthecounter derivatives and securities markets. TheSMDArespectfullyrequeststhattheCommissionadditionallyconsideritsearliercommentletterto theCFTCwithregardtoblocktradethresholds,datedFebruary2,2012. Introduction SettingblocktradethresholdscorrectlyforSEFtradingisimportanttoensureincreasedtransparencyin theOTCswapsmarketplaceforapostDoddFrankworld.Toolowablockthresholdandfewertrades will be executed on SEFs as little structural change in swaps execution occurs, increased competition fails to manifest itself and more diverse liquidity is impaired. Too high a block threshold and the liquidityproviderislegitimatelyputatriskasavailablemarketliquidityattimeoftradefailstoabsorb

D.Stawick May14,2012 Page2 the block traders offsetting trade or hedge completely, which in turn also has a negative impact on structuralliquidity. Theblocktradethresholdrulethenshouldbebalanced,flexibleandadjustasmarketconditions,inthe longrun,adjust.TheSDMAassertsthattheCFTCblocktradethresholdmethodologyforinterestrate swapsandcreditindicesisappropriateinitsapproachofpercentageofnotionaltradedsetat67%,but respectfullyrecommends,thatwhenconsideredinconcertwiththemarketdepthandbreadthapproach (discussedbelowandinQuestion35.a),suchathresholdshouldbesethigherat75%oftradenotional.1 CongressionalIntent:50%,67%or75%? SixtysevenpercentoftradenotionalisconsistentwithCongressionalintent.WhendebatingtheDodd FrankActin2010,Congressarguedthattheguidingprincipleinsettingappropriateblocktradelevels shouldbethatthevastmajorityofswaptransactionsshouldbeexposedtothepublicmarketthrough exchange [or SEF] trading.2 The SDMA submits that that the CFTC is correct to assert that vast majorityequateswith67%percentoftradenotional.Infact,theSDMAbelievesthatvastmajority shouldequatewiththemoreappropriate75%percentoftradenotionalfortheblocktradethreshold. That Congress did not intend that vast majority equate with 50%, is clear by definition, such a percentageisnotevenasimplemajority.Simplyput,hadCongressintendedthat50%oftradenotional betheblocktradethreshold,itwouldhavesaidsoitwouldhavedeclaredhalfofswapstransactions shouldbeexposedtothepublicmarket.Therecordplainlyshowsotherwise. That Congress did intend a higher percentage of trades well above 50% is supported by the fact that Congress also intended that the trade reporting tape have value and meaning to the marketplace. Discussedbelow,suchapercentageislowwhencomparedwithaveragetradesizeandsuggestedblock thresholdsfromamarketdepthanalysis.Forexample,forthethreeyearinterestrateswap,50%would equatetoa$240Millionnotionalblock.Thisisonlyslightlyhigherthantheaveragetrade$221million notionalamere$19millionor8.50%difference. Atapethatreportedablocktrade1530minutesinarrears,whereitstruesizeisalsoshielded,and wheretheblocktradewasslightlyabovetheaverageticketsizewouldhavelittlepracticalsignificance and value to the market. Because a tape based on a 50% threshold would have little value to the market,itiscontrarytoCongressionalintentandshouldnotbepermissible. MarketDepthConsideredRelativeto50%ofNotionalQuestion35.a But50%oftradenotionalshouldbediscountedbecauseitsnotatruereflectionofliquidityconditions inthemarketbasedontheMarketDepthandBreadthtest. TheCommissiondefinesablocktradetobelargesizedtransactionsthatwouldcauseasignificantprice impactifrequiredtobeexecutedontheDCMscentralizedmarket.Inotherwords,ablocktradeisa trade whose size is so large that it cannot immediately be absorbed by all the current or available liquiditybids or offersin the marketplace during a given time period at the current price. Thus, it
1

TheSDMAsupportstheCFTCBlockTradeThresholdforCommodities,ForeignExchangeandEquitybased product.ThefocusofthiscommentletterisInterestRateSwapsandCreditDerivativeIndices. 2 S5922(CongressionalRecord,July15,2010).

D.Stawick May14,2012 Page3 follows;theblocktradethresholdshouldbeequaltosumofordersavailabletotheblockmarketmaker totradeagainst. Fortheswapseller,therefore,iftheblocktradeamountthatitwishestosellishigherthanthesumof availablebidsinthemarketplaceatthecurrentprice,thenitisclearthattheentiretradesizecannotbe absorbed by the market and that trade is certainly a block. But if the block trade amount that the sellerwishestosellisbelowthesumofallbidsinthemarketplaceatthecurrentprice,thenitisalso true that such a trade cannot be a blockbecause it is readily absorbed by the markets available liquidityanddoesnotmovethemarket. To better illustrate this example consider Exhibit A attached from Bloombergs ALLQ trading system fromFebruary24, 2012.BarclaysquotesthetwoyearinterestrateswapatBid:0.603/Offer:0.613, bothbidandofferfor$400MMnotionalinsize.ThatmeansthatBarclays,adealer,willbuy$400MM at0.603yieldandselltoyou$400MMat0.613yield.Forthelayperson,thesearelargenotionalstobe sure,butnotatypicalintheswapsmarketwheretheaveragetwoyeartradesizeis$344million. Forthetwoyearswap,tosettheblocktradethresholdequalto$460MMwouldbetosetthethreshold onlymarginallyhigherthatthequotedsizeof$400MMthatBarclays,oneoutofseveraldealers,was willing to trade with a customer. Presumably, the other listed dealers showing quotes at the current pricefor$750MMwouldbewillingtobuytheremaining$60MM. It is fair to conclude that setting the block threshold equal to $460MM is not the optimal threshold becausethemarketcanreadilyabsorbsuchsize.Inthiscaseonedealercanabsorb$400MMalone, with the remaining $60MM absorbed by the other quoting dealers. As a result, the 50% of trade notional approachthat suggests exactly $460MM as its block trade threshold is too low relative to available liquidity in the marketplace. In this instance, it is difficult to see how the liquidity provider wouldbeharmedandconsequentlyneedtheprotectionofablockrulewhenitstradesizeisreadily absorbedbythemarket. ButistheBarclaysquoteananomalyortrulyreflectiveofonequotefromonedealeroutofmany?To answerthis,weconsiderMarketDepthandMarketBreadth. MarketDepthTest WearguethatrulemakersshouldsettheblockthresholdatleastequaltotheMarketDepthdiscussed inQuestion35.a. Discussed in more detail in our earlier letter, the SDMA defines Market Depth (MD) as the sum of ObservedLiquidity(OL)attimeoftrade.3Fortheseller,availableliquidityisthesumofallbidsatthe currentpriceforagivenswap.Forthebuyer,itisthesumofalloffersatthecurrentpriceforagiven swap.

MarketDepth=OL

Seepage2oftheSDMALettertoCFTCRIN3038AD08:RealTimePublicReportingofSwapTransactionData, dated2/2/12.
3

D.Stawick May14,2012 Page4 Figure1(below)considersMarketDepth,whichisequaltoObservedLiquidityforthelargestandmost liquid US interest rate swap market: dollar denominated, 3 month Libor indexed swaps.4 The first column is the swap maturity. The second column shows the screen size or the standard size increment in which the swap price is customarily quoted by market practitioners. The third column displays average trade size. The fourth column displays swap sizes as a function of the 50% of trade notional approach. The fifth column displays notional swaps sizes as a function of the 67% of trade notionalapproach.ThesixthcolumnconsiderstheObservedLiquidity(OL).
Swap Maturity Screen Average 50% 67% BlockSize Observed Liquidity MD BlockSize MultipleofMD 50% 67% Size(MM) TradeSize* BlockSize

2yr 3yr 5yr 7yr 10yr 30yr

200 150 100 75 50 25

344 221 126 113 85 52

460 240 240 170 170 120

750 380 380 290 170 210

1,493 1,131 762 524 392 168

1,493 1,131 762 524 392 168

0.3 0.2 0.3 0.3 0.4 0.7

0.5 0.3 0.5 0.6 0.4 1.3

*LCHDatafrom1/25/2012

MarketDepthMethodDiscussed ToarriveatObservedLiquidity,wesampledsixdealersliveactionablepricesforeachofthefollowing:2 year,3year,5year,7year,10yearand30year.Thisisaconservativeapproachbecauseweassumed thatonlysixdealersexistinthemarket.Daily,wesampleddealersbidsizeandoffersizeatthecurrent price.Wedefinedcurrentpricetoequalthehighestbidorlowestofferinadditiontoquotescaptured withinaquarterbasispointofthehighestbidandlowestoffer.Likewise,weignoredordersizewhenit wasassociatedwithbidslowerthanoroffershigherthantheacceptablecurrentprice. We then took the average of each daily observation for a given swap over the given time series5 to arriveatObservedLiquidityfortheparticularswap(OL).6WithregardtothesuggestedMarketDepth methodinQuestion35.a,theSDMAbelievesthattheCommissionsapproachisconsistentintermsof approach.TheSDMAsampledsixdealersconsistently,whichisconservative,butagreesthatsampling the entire marketplace through SEFs, as suggested in Question 35.a is a more scalable test and more representativeofthemarket.7
Forconveniencepurposessuchatestisinterestrateswapbased.Thesametestcanberunforcreditindicesor indeedanytradedproduct. 5 WetookcollateddatafromeachdealeroverthetimeintervalfromJanuary2012toApril2012. 6 Sincedealerstypicallyquotedthesamesizeforboththebidandtheofferforaparticularswap,theObserved Liquidityonlycapturesonesideeitherallbidsoralloffers.Thisproperlyaccountsforobservedliquidityavailable toeithertheswapsellerorswapbuyer. 7 TheSDMArecommendsthattobettertrimthedatasetinQuestion35(a),theCommissiontrimbidsandoffers withasimilardefinitionofSDMAcurrentprice.Toachievethis,itisrecommendedthattheCommissiontake halfthebidofferspreadandcapturesuchorderswithinthebidandthisrangevalueandlikewisetheofferandthis rangevalue.
4

Figure1.MarketDepth,50%&67%Considered

D.Stawick May14,2012 Page5 BlockThresholdsDetermined SettingObservedLiquidityequaltoMarketDepth,wearguethatthisistheoptimalnotionalamountat whichblocktradethresholdshouldbeset.TosettheblockthresholdbelowtheMarketDepthwould meanthattheblocktradeisreadilyabsorbedbythemarket,withsomeresidualliquidityremaining thisbydefinitionisnotamarketmovingtrade.Suchatradewouldnotresultinharmtotheblocktrade liquidityprovider. Conversely,tosettheblockthresholdabovetheMarketDepthwouldmeanthattheblocktradeisnot readilyabsorbedbythemarket,becausesomeresidualamountwouldstillremainthisbydefinitionis amarketmovingtradeorblocktrade.Suchatradewouldresultinharmtotheblocktradeliquidity provider. ConsiderFigure1aboveforthetwoyearswap.TheObservedLiquidityandMarketDepthindicatedis $1.493billioninnotionalsize.Thatmeansthatthemarketcouldabsorb$1.493Billionatthecurrent pricewithoutmovingthemarket.Whenconsideredrelativetothesuggestedblockthresholdof50%of trade notional of $460MM, which is 30% of the Market Depth amount, it is clear that the 50% block thresholdnumberistoolowandshouldnotbeadopted. Whenconsideredrelativetothesuggestedblockthresholdof67%oftradenotionalof$750MM,which is50%oftheMarketDepthamount,itisclearthateventhe67%Blockthresholdnumberisalsotoolow andshouldberejectedinfavorofalargepercentageoftradenotional.TheSDMArecommends75%. Suchafindingisalsoconsistentacrosstheyieldcurve:3year,5year,7year,10yearandeven30year swaps. Only at the 67% of trade notional threshold for 30 year swaps does the suggested threshold amount,$210MM,exceedthesuggestedMarketDepthblockthresholdof$168MM. But our Observed Liquidity only considers six dealers. What about the liquidity that another 2025 marketmakersmayprovide? Thus, based on our first test the Market Depth test we suggest that block thresholds for dollar denominated,Liborindexedswapsbethefollowing:2year($1,493MM),threeyear($1,131MM),five year($762MM),sevenyear($524MM),tenyear($392MM)andthirtyyear($168MM). MarketDepthTest&TimeConsiderations The Market Depth test is conservative also because it ignores additional available liquidity within the delayed reporting window set by the CFTC. The CFTC has recently mandated that such a time period shallbe30minutesforthefirstyearandthen15minutesthereafter. As previously discussed, a block trade is a trade whose size is so large that it cannot immediately be absorbedbyallthecurrentbidsoroffersinthemarketplaceduringagiventimeperiod.Ifthemarket makerhas30minutesinwhichtohedgeitspositionortradeoutofthepositioncompletelywhatisthe likelihoodthatnewbidsandoffersappearinthemarketwithinthattimeframe? TheMarketDepthtestonlycapturestheObservedLiquiditythatisimmediatelyavailabletobesweptby theblockmarketmaker.Itdoesnotcapturethesubsequentpricesthatwouldenterthemarketinthe 30 minute hedging window that follows. Because it is highly likely that several new bids and offers

D.Stawick May14,2012 Page6 wouldenterthemarketplacewithinthe30minutewindowpostimmediateliquiditybeingsweptbya block trade, the Market Depth test and its resultant block trade thresholds suggested here should be viewedastheconservativelowendofwherethresholdsshouldbesetbytherulemaker. MarketBreadthTest But what about off coupon and off maturity swaps? Can you measure the Market Depth for each individualswap? Analyzing well established trading and hedging techniques of less liquid swaps, we find it is not necessary. TheSDMAagreeswiththeMarketBreadthtestassuggestedinQuestion35.a.Suchatestrecognizes that swaps are traded, hedged and risk managed on a portfolio basis by market makers. Simply put, currenttradingpracticeandriskmanagementtechniquesrecognizethatmarketmakersrarelyhedgeor tradeoutofoffmarketblockpositionsusingtheexactswapinquestionthefocusswap. Instead, market makers synthetically create an opposing or hedge position that replicates the risk characteristicsofthefocusswap.Hedgerscreatesuchasyntheticpositionbyuseofabasketofswaps withinthesamecategory.Forexample,tohedgea$500Million8.10year,USDollardenominated,3 month Libor swap, the trader could create a synthetic opposing position with a basket of 7, 8 and 10 yearUSdollardenominatedinterestswaps. Todeterminetheblocktradethresholdthenforanoffmarketswap,hedgersconcernthemselvesnot withtheliquidityofspecificfocusswaptraded,butwiththesumoftheavailableliquiditythatexistsfor theswapsofthesamecategoryfromwhichthetraderusestohedge.Thusforthe8.10swap,theblock trade threshold should equal the sum of Market Depth for a possible liquid swaps within the same category.

MarketBreadth=OLfocusswap,liquidswaps(samecategory)
The SDMA submits that the categories suggested by the Commission are generally consistent with marketpracticeindeterminants:currency,index,callable/noncallable,maturityortenor. The Market Breadth test is conservative because it only considers liquidity of liquid swaps within the samehedgingcategory.Itispossibletousenoncategoryswapsforhedgingpurposestoavailoftheir liquidity if desired or necessary. For example, you could hedge a five year swap with a two year and thirtyyearswap. TheMarketBreadthtestisconservativebecauseitignoresavailinghedgingtoolssuchasUSTreasuries or Euro Dollar Futures. Using Eurodollar futures, which are highly liquid, can prove to be quite an efficienthedgeespeciallyintheshorterswapmaturities.Thus,itcouldbearguedthattheliquidityof suchtoolsbeincludedineachrespectiveswapcategory. DataAvailabilityForMarketDepthandBreadthTests TheSDMAsampledsixdealersandassumedthemtobethecompletepoolofliquidityproviders.Fora more complete data set, however, the SDMA agrees with the Commission approach to capture data

D.Stawick May14,2012 Page7 directlyfromSEFsandDCMs.TheCFTChasauthoritytocapturesuchdataandprovidingsuchdatato theCommissionshouldnotprovedifficultforSEFs.MostSEFstypicallycapturethisdataalready. The SDMA recommends that the Commission adopt such an approach at its earliest convenience, perhapsaftersixmonthsofdatacapturefromSEFsandDCMs. Conclusion TheSDMAsubmitsthattheCFTCblocktradethresholdmethodologyforinterestrateswapsandcredit indices is appropriate in its approach of percentage of notional traded set at 67%, but respectfully recommends,thatwhenconsideredinconcertwiththemarketdepthandbreadthapproachdiscussed inQuestion35.a,suchathresholdshouldbesethigherat75%oftradenotional. Boththemarketdepthtestandthepercentofnotionaltradedtestshouldbetakentogetherforthefirst yearuntildatagatheredbecomessignificant.Inthelongrun,themarketdepthtestproperlyconsiders liquidityasafunctionofordersnotjusttradesandproperlysetstheoptimalblocktradethresholdnot onlyforOTCderivatives,butalsoforotherassetclasses.Suchatestisscalable,easytoadministerand wouldbecheaptocreate.Intodaystechnologyenvironment,datacaptureandaccessibilityhasalso becomelesschallenging. RespectfullySubmitted,

MikeHisler SDMA mhisler@thesdma.com cc: TheHon.GaryGensler,CommissionChairman TheHon.BartChilton,Commissioner TheHon.MarkWetjen,Commissioner TheHon.ScottD.OMalia,Commissioner TheHon.JillE.Sommers,Commissioner RULEQUESTIONSANSWERED Should the Commission provide for special swap categories and appropriate minimum block size methodologies for bilateral versus cleared swap transactions? If so why? (Question Number 1 (p. 15468)) TheCommissionshouldapplyonetestforeachswapcategory,regardlessofclearedversusbilateral. Are the proposed criteria, by tenor and currency type, the correct approach for determining swap categories in the interest rate asset class? Should any other characteristic be considered to create categories?(QuestionNumbers28(p.1547273))

D.Stawick May14,2012 Page8 Swaps are traded and risk managed on a portfolio basis. For illiquid offtenor or offcoupon swaps, marketpractitionersgenerallydonotseektotradeouttheblockpositionimmediately.Instead,market makers replicate the swap synthetically using a basket of liquid swaps around such a position. The liquidity provider then executes the opposing synthetic swap to hedge the off market position. Thus, the guiding principle for categorization should be what hedging tools will most likely be used by the hedger and from these instrument clusters, categories should be formed. The CFTC categories are thereforeappropriateandaccurateintermsofcurrency,index,andtenor. Isthe67%notionalamountcalculationtheappropriatemethodologyforcalculatingminimumblock sizeforIRSandcreditassetsclasses?QuestionNumber32(p.15480)Isthereanypartoftheswaps marketforwhicha50%notionalamountmethodologywouldbeappropriate?(QuestionNumber33 (p.1548081)) Consideredrelativetoamarketdepthandmarketbreadthanalysis,discussedabove,theSDMAbelieves that75%ofnotionalisamoreaccurateandsuitablecaptureoftrueblocktradethresholds. Insteadofthe67%notionalamountcalculationtheappropriatemethodologyshouldtheCommission based minimum block size on alternatives tests such as: (a) market depth and breadth Question Number35.a(p.15482),(b)averagevolumeinagiventimeperiod,QuestionNumber35.e(p.15483) (c) the volume of a portion of trades, Question Number 35.f (p. 15483) (d) impact of trade sizes on price?QuestionNumber35.h(p.15484)Istheproposedmethodofusingatrimmeddataset(i.e.;a datasetinwhichextraordinarilylargenotionaltransactionsareremoved)appropriateforcalculating minimumblocksize?(QuestionNumbers34.aand34.b(p.15482)) The SDMA supports the market depth & market breadth methodologies discussed in Question 35.a. Such an order driven approach taken in tandem with the trade notional approach will return a more completeanalysisfromwhichblocktradethresholdsmaybeset.TheSDMArecommendsthattheCFTC adopts the market depth & market breadth approach as the data becomes available from execution venues. The SDMA does believe that average volume in a given time period method is an accurate or reliable test. Please see earlier SDMA analysis of ISDA average volume test in SDMA comment letter to CFTC withregardtoblocktradethresholds,datedFebruary2,2012. IstheCommissionsapproachthatitdeterminesminimumblocksizecorrect?QuestionNumber61 (p.15489)Alternatively,shouldaSEForDCMdetermineminimumblocksize?QuestionNumber62(p. 15489)IftheCommissionweretopermitSEFandDCMtodetermineminimumblocksize,whatwould beappropriateparameterstogivetoSEFandDCMtoensurethattherearestandardminimumblock sizes?(QuestionNumber62b(p.15489)) TheSDMArecommendsthattheCFTCsettheblocktradethresholdfortrading.Itisnotuncommonfor OTC derivative execution venues to experience and/or succumb to external pressures from its largest liquidity providers in exchange for increased order flow. Thus, SEFs could opt to lower block trade

D.Stawick May14,2012 Page9 thresholds for their own financial gain, but at the expense of transparency, competition and more democratizedmarketliquidity.Withfewliquidityprovidersstilltoday,andpretradetransparencynot guaranteed,suchpressureswillpersistuntilregulatorsensurealevelplayingfieldthatinturnattracts moreliquidityproviders,greatercompetitionandlessenedincumbentinfluence. Isthemethodforsettinginitialcapsizethemaximumnotionalamountthatisreportedonablock tradeappropriate?QuestionNumber71(p.15493)Theinitialcapsizeisthegreaterofblocksizeset inAppendixFandthosestatedin43.4(1)(i)(forinterestrateswaps$250millionforIRSwithtenorof uptotwoyears,$100forIRSwithtenorbetweentwoand10years,and$75millionforIRSwithtenor ofover10years)and43.4(h)(1)(ii)(forcreditsassetclass$100million).Istheuseof75%ofnotional amountcalculationappropriatefordeterminingpostinitialcapsizes?QuestionNumber72(p.15493) TheSDMAsupportstheproposedCapSizeruleforinterestrateandcreditdefaultindices.Suchacap size(75%ofnotionalsize)isappropriateandconsistentwiththeSDMAsrecommendationthat,when consideringperofnotionaltraded,blockthresholdsshouldbesetequalto75%,andnot67%ofnotional traded.Discussedabove,theSDMAbelievesthat,whenconsideredinconcertwithmarketdepthand breadthmethodologies,75%ofnotionalismorerepresentativeofactualblocktradethresholdsinthe swapsmarket.Giventhattheliquidityprovideralsohas30minutesinyearone,and15minutesineach year thereafter, to report the trade to the market, the SDMA believes that the liquidity provider is appropriatelyprotectedfrommarketforcesthatmightotherwiseactagainstit.

D.Stawick May14,2012 Page10 ExhibitA:BloombergAllQ,2/24/2012